Hi everyone.
Today we're going to use Texas BA II Plus financial calculator to solve a word problem
involving compounding interest.
So let's look at example.
Muhammad asked his friend Julie to lend him $10,000, so that he can buy a car.
Muhammad will pay the money back in four years and he agreed to pay the interest of 10% per
year, compounding annually.
How much does Mohammed need payback to Julie at the end of the fourth year?
Let's first draw a timeline.
Mohammad liked to borrow $10,000 now, in order to buy a car.
This $10,000 is called principle, also present value.
We have PV, short for present value.
In the future, at the end of the fourth year, so four years, Mohammad will pay back Julie
the amount.
Which, we don't know how much that's going to be.
That's the maturity value, also called future value.
FV for future value.
In order to solve a compound interest problem, we need identify seven variables.
First CY, compounding per year.
PY, payments per year.
We also need to look at a calculator.
We need that five button on one row.
So, we have N, IY, PV, PMT and FV.
So, we have present value, we already identified as $10,000.
Future value, the amount Mohammed will pay back, that's unknown.
PMT stands for periodic payments.
In this case, we don't have periodic payments, so periodic payments are like monthly payments
to mortgages, or credit debts, in this case periodic payments zero.
Interest is 10%.
10% interest.
For calculated entry we will drop the percent, just write down 10.
The interest compounding annually, that means compounding once a year.
So, compounding period, per year, is just one.
For PY, PY represents payments per year, but in this case all periodic payment is zero.
In such cases, PY takes same value as CY.
N is lump number of compounding periods.
So, we're talking about four years period, and the compoundings once a year.
So, N is four times one, goes to four.
Later on, when we look at the examples for annuities, you will see N represent number
of periodic payments.
In either case compound interest, or annuity calculations, you can always use the formula
N equals to number of years, times PY.
Now we have all the information we need and we're ready to use calculator to solve the
problem.
Okay, so on the calculator we're going to push on and off button to turn on.
Most calculators by default has two decimals, so let's change it to nine decimals first.
Push second on the format, change decimal to nine, so push nine, and enter.
Please be careful, if you forgot to push the enter key, your number will not be entered
properly.
Now second, quit to exit.
Next we're going to enter the values for CY and PY by enter second PY.
First PY is one, so push one, enter.
Scroll down, CY by default is same value as PY.
We'll change it anyway, just one, enter, as a practice.
Push second and quit to get out there.
Now for this row, N, IY, PV, PMT, and FV, four all this five keys, as long as you know
four numbers you will be able to calculate the remaining one.
Let's enter value N, is four.
So, four N.
So, remember you have to push the value first and then the button.
For interest rate, is 10 IY.
PV is 10,000, PV.
PMT is zero, and the future value is unknown, but we already have this four numbers.
We'll be able to calculate future value by press compute FV.
So, future value is $14,641.
You'll notice in the future value it shows negative.
That's because PV and FV always take opposite sign representing cash inflow and the cash
outflow.
You may also consider that as money come at you, or money leaving you.
So for Muhammad, getting $10,000, that's a cash inflow, and the paying out 14,641 is
negative.
He lose that much money.
But, if you think from Julie's perspective, Julie would lose $10,000 and the gain 14,641,
let's try that.
If we change present value to be negative and now we compute future value, you will
see a positive 14,641.
It doesn't matter, just keep in mind they have to be opposite sign when you use the
calculator.
Now we have solved the problem.
Thank you for watching.